The Shifts and the Shocks—What We’ve Learned-and Have Still to Learn-from the Financial Crisis

By Martin Wolf

Prior to the financial collapse of 2008, Wolf was, by his own admission, an ‘orthodox’ economist.

This book records his re-evaluation of those ideas and his transition to a radical solution.

Like many other economists (Krugman, Stiglitz, Piketty) he identifies the root problem as the “chronic demand deficiency” in the high income countries. Rising inequality results in the rich saving too much (a savings glut) and the rest in spending too little. The lack of demand depresses the economy and government revenues. The response is invariably austerity, as in Canada today, which only makes things worse. Some countries like Germany and China combat the lack of domestic demand by running large current account surpluses, forcing others to run deficits and import capital.

This produces lower interest rates in the deficit countries and causes an explosion of borrowing and debt. Most of this borrowing does not go into expanding production or employment (given insufficient demand) but into existing assets. Hence the current housing price inflation in Canada.

Wolf places most of the blame on a “predatory” financial system, which profits immensely by increasing our debt. He rejects the dominant fractional reserve model of banking as unstable and dangerous. While he supports current proposals for more regulation, higher capital and reserves, limits on leverage, he does not believe that they will prevent another crisis. Our current financial system, he writes, “is a credit and debt creating machine.” To make matters worse, it is pro-cyclical. In good times it can create almost unlimited credit (debt) and the bubbles expand and inevitably burst. Those loans are defaulted, banks lose their capital and constrict credit, and the economy goes south. Central banks are supposed to control this dangerous tendency, but in practice (being run by bankers) they have failed to do so. In an expansion, the profits–and bonuses–are huge; in a collapse the government has to rescue them.

Wolf understands, as few do, that banks create money in the process of making loans and sees the fundamental problem as “the ability of profit seeking institutions to create money as a by-product of often grotesquely irresponsible lending.” Wolf calls this “a deal with the devil” because it distorts our monetary system, causing escalating debt, credit bubbles and recurring crises.

Wolf’s solution is radical, but not new. “Let money be created by the state” either directly or by the central bank. Few Canadians are aware that the Bank of Canada created almost half of new money during the early stages of WWII and continued to create a substantial portion until 1974 when the bankers regained control. Since then, we have been forced to rely on bank created money.

Societal debt has escalated, as it must under a debt money regimen, and growth has slowed. While Wolf’s proposal of 100 per cent of legal tender may sound extreme, I have no doubt that a much higher proportion of real money is an essential precondition for prosperity and stability.